Today’s does of non-Ukraine content concerns a misunderstanding about commodities that seems to require regular correction. I’ve seen it resurface recently, most recently in a daily digest from Bloomberg this morning:

“There seems to be something of a vicious circle developing in the commodities space, where investors are increasing their exposure as an inflation hedge, thereby possibly driving up prices further. “

This is not something you should worry about.

I suspect this sort of thinking derives from observations about financial futures, in particular cash-settled sorts. But in contracts for physical delivery, it doesn’t work this way. A purely financial investor cannot drive up prices in the spot market, because such an investor never gets to the spot market. No one, outside of a few sophisticated hedge funds, holds physical commodities as an inflation hedge (with the possible exception of precious metals, which isn’t what they’re discussing here). No one keeps a silo of corn or beans for investment, taking that supply off the market in the process. (Almost) no one keeps a tanker truck of gasoline as an inflation hedge or a pile of aluminum.[1] A financial investor must cover their (long) positions by finding an offset before delivery. Only buyers who actually want the commodity delivered, or sellers who actually have the commodity to deliver, go all the way to final settlement. Ergo, the spot price is determined by actual buyers and sellers of the spot commodity and not financial players.

So, if financial investors in commodities do anything at all, they might push up deferred contract prices relative to spot prices, putting the market further in contango. If anything, this actually would cause the opposite effect from the one noted above since a producer who owns future commodities (in other words, they make production decisions about how much to grow or mine) can lock in a higher selling price than the current spot price – which obviously would make them want to supply more to the market.

But if this was the dynamic, then commodities curves would be in contango (deferred contracts higher than spot contracts); instead we find that commodities curves are in backwardation at levels we haven’t seen in a long time.

[N.b.: if you have the Inflation Guy mobile app, you can look for the Daily Chart Pack under “tools” and on page 17 you will find this chart, updated every day.]

Commodities curves being in backwardation is actually one strong piece of evidence that financial buyers are not driving volatility or activity in commodities markets. Curves are in backwardation because there are shortages in the spot market but producers are still willing to sell future production lower than the current level.

In short – don’t blame the financial players for the rise in commodities prices. Blame years of underinvestment followed by massive money-stoked demand. It’s not hard to see why commodities have risen so much. It’s only hard to guess how much farther they will go. But their answer, in any event, will not depend on how heavily invested institutions or the general public are.

[1] That can occasionally include pure arbs doing cash-and-carry metals arb, but that’s not much fun when the curves are backwardated like they are now.